With the end of the year approaching, it’s easy to sit around wondering where the year went. It seems like the year just flew by! But don’t get stuck in the past while you should be getting ready and focused for what next year will bring— and what lies ahead. One important way to start the new year off right is by making sure your IRA beneficiary information is up-to-date. There are so many reasons this choice is important and there’s a lot to consider, but we’re here to help you make an informed choice.
We’ll be talking about “Inherited IRAs” and “Beneficiary IRAs” in the below sections— these are both industry terms used to describe an IRA that has been inherited after the death of the original account holder. These terms can be used interchangeably but do not describe the tax-status of your account— if you are unsure what type of account you hold, you should check with your IRA Provider.
Why You Should Update Your Beneficiaries— Even if You’ve Updated Your Will
Updating your beneficiaries is essential because the beneficiaries you list on your IRAs supersede your will or trust. This means that even if you update your other end of life documents, you’ll need to make sure to update your IRA beneficiary information as well. In the industry, we hear stories of long-estranged ex-spouses inheriting IRAs intended for others, all due to outdated beneficiary information— don’t let this be you. To make sure this doesn’t happen, update this information with IRA Resources by filling out and submitting a Beneficiary Form (located here) as soon as your selections change. If you are listing a trust as a beneficiary, you’ll need to include a copy of the trust documents as well.
Who Should You Name as Your Beneficiary?
Who you name as your beneficiary, and the difference between the types, is also important. You can name many individuals or institutions as a beneficiary, and the type and percentages make a difference in who ends up inheriting your IRA. Any of the following can be listed as your beneficiary:
- Your Spouse
- Your Children, Grandchildren, or Other Individuals (i.e. friend)
The two types of beneficiaries are “Primary” and “Contingent” beneficiaries. A primary beneficiary is the individual (or in the case of a trust, the legal document) that you want to receive the assets in your IRA first in the event of your death. You can have more than one primary beneficiary— it doesn’t have to be all or nothing. You can choose 100% of the IRA to be paid to one person or split the IRA into percentages for each beneficiary (for example, a 50/50 or a 75/25 split). If you name several primary beneficiaries and one dies before you, then that person's share is divided equally among the surviving primary beneficiaries (unless you say otherwise). If the primary beneficiary is a trust, we typically see the trust as a 100% primary beneficiary (since the trust will specify how you want the IRA assets distributed).
A contingent beneficiary is an alternate person (or in the case of a trust, the legal document) who receives the assets in your IRA if none of your primary beneficiaries survive you. An example we see regularly is listing a spouse as the sole primary beneficiary and the children of the IRA holder as the contingent beneficiaries. This way, if the primary beneficiary (the spouse) passes first, the children are already listed as contingent beneficiaries and no updating is needed.
Opening a Beneficiary IRA
The process for opening a Beneficiary IRA is the same as any IRA at IRA Resources. In addition to the new account application and other paperwork, we’ll need the original death certificate for the IRA account holder (we will return the death certificate once we have verified its legitimacy). The primary difference during this process is the Beneficiary IRA is titled differently than an IRA you would open normally. The deceased IRA account holder’s name is also listed on the Beneficiary IRA.
Example: IRA Resources FBO Jane Doe as beneficiary of John Doe
Even though the account titling is different and a death certificate is required, we don’t charge extra for a Beneficiary IRA. The fees for a Beneficiary IRA are the same as our other IRA accounts. If you’d like more information on our fees, you can find that here.
The Differences Between Spouse and Non-Spouse Beneficiary IRAs
The options a beneficiary has changes depending on who is inheriting the IRA. The biggest difference is if the beneficiary is a spouse— the spouse can treat the inherited accounts as if they were his or her own. This means the spouse can transfer the assets into their own existing or new IRA. The money is available to them at any time, to be treated as if it were the spouses’ own. This includes if the money is taken out (distributed) before the spouse is 59 ½ for an inherited Traditional IRA— though this is still considered an early withdrawal and the penalty will apply.
Both spouse and non-spouse beneficiaries inheriting an IRA (where the account holder was under 70 ½ and not yet taking Required Minimum Distributions) have the following options:
- Open a Beneficiary IRA (Life Expectancy Method)
- Distributions must begin no later than December 31st of the year the account holder would have reached 70 ½, with the annual distributions spread over the beneficiary’s life expectancy.
- If there are multiple beneficiaries, separate accounts for each beneficiary must be established by December 31st of the year following the year of death
- Open a Beneficiary IRA (5-Year Method)
- The money is available at any time, up until December 31st of the fifth year after the year in which the account holder died, at which point all assets need to be fully distributed.
- You will be taxed on each distribution, but you will not have to pay the 10% early withdrawal penalty
- Lump Sum Distribution (Beneficiary Doesn’t Open an Inherited IRA)
- All the assets the IRA owned are taken out immediately.
- You will be taxed on the distribution, but you will not have to pay the 10% early withdrawal penalty
If the account holder was older than 70 ½ at their time of death, the 5-year method is not an option for the spouse or non-spouse beneficiary. The remaining options would still apply. If you’d like additional information about the IRS rules and regulations around beneficiary IRAs, they have resources here.
The spouse and non-spouse beneficiary have different options when it comes to moving the inherited IRA funds. Non-spouse beneficiaries need to transfer directly from one account to another, or from one IRA custodian to another. Unlike the spouse beneficiary, the non-spouse beneficiary doesn’t have the option for a distribution or a 60-day rollover when inheriting IRA assets. If a non-spouse beneficiary takes a distribution (assets or a check), not only is the distribution taxed as ordinary income, it is ineligible to be rolled into the Beneficiary IRA it was originally taken from or one at another firm. A non-spouse beneficiary can NEVER do a 60-day rollover of Beneficiary IRA funds.
If you inherit IRAs from different owners, you cannot combine them into a single inherited IRA because of the titling requirements mentioned above. If you have inherited multiple IRAs (of the same account type) from the same original owner, you can combine them.
Example: If a beneficiary inherited two IRAs from their Mom (a non-spouse beneficiary), they can be combined into one beneficiary IRA. If at some later point, the same beneficiary inherits an IRA from their Dad (who had also inherited an IRA from Mom), this IRA comes from Dad, not Mom. It cannot be combined with those previous two IRAs inherited, even though they were all Mom’s IRAs at one point. The main reason for this is that the Required Minimum Distributions (RMDs) on the inherited accounts will be calculated differently. RMDs on accounts that are inherited directly are generally based on the beneficiary’s age in the year after the account owner’s death.
Taxes Due When Distributing Inherited IRAs
Whether or not you’ll owe taxes on an inherited IRA depends on the type of account you have inherited. With an Inherited Traditional IRA, the beneficiary will pay taxes on any distributions they take. With an Inherited Roth IRA, they don’t pay taxes on distributions, just like a regular Roth IRA. A Beneficiary IRA maintains the tax advantages (traditional or Roth) of the original account.
Who you name as your beneficiary is important— and keeping that information updated is almost as important. Most of the rules with Beneficiary IRAs are the same, but there are some very important differences to keep in mind. If you’re a spouse inheriting your spouse’s IRA, you can more or less treat the account as your own (with some exceptions)— non-spouse beneficiaries have additional restrictions. To make sure your hard-saved funds to go where you intend, ensure your IRA provider has the correct and updated beneficiary information on file. We aim to help make saving for your retirement as easy as possible, for you and your descendants. If you have any questions about beneficiary IRAs or anything else, please reach out and we’d be happy to assist in any way possible.